Expert advice for franchisees wanting to build a multi-unit business

By Pauline Cowie, partner at law firm TLT

The latest British Franchise Association NatWest survey recently confirmed that franchising is firmly on the boardroom agenda as a way of achieving faster expansion, whether that’s in the UK or overseas.

This is being driven by trends like multi-unit franchising, which enables franchisees to use their existing infrastructure to manage and acquire a number of sites and leverage their expertise. For franchisors, it allows for accelerated expansion with a professional and talented franchisee.

Strategic plans
Investors with long-term goals to develop a high growth franchise business as a franchisee need to consider their strategic plans and appetite for risk and how these will fit with the expectations and requirements of the franchisor.

Unless the franchise proposition has been developed with high growth franchisees in mind, it is likely that the franchisor will need to change its standard approach to accommodate the prospective franchisee’s ambitions. Otherwise the investors will not have the confidence to make their investment and put the building blocks in place to achieve accelerated growth.

With this in mind, the franchisee must consider the constraints of the proposed franchise agreement and any changes that may need to be discussed with the franchisor when negotiating the terms of the agreement and documenting the franchise relationship.

To be clear, a prospective franchisee shouldn’t be looking to change the fundamental operating model of the franchisor. It is more a case of the parties mutually recognising that what works with a smaller franchisee isn’t an attractive proposition for a more sophisticated franchisee with substantial management experience and/or investment levels and plans to establish a multi-unit operation or when adding the franchise brand to an existing portfolio.

Of course, the franchisor may not agree to make any changes, but our experience shows that there are advantages to be had by addressing the particular concerns of a high level investment or experienced investor with high growth plans.

Commercial considerations will dictate whether the deal on the table will work for both parties and whether the franchisor will be willing to deviate from its tried and tested approach.

Issues to consider
The franchisee must consider how its proposed structure will impact the franchise agreement, particularly where there are a number of different shareholders involved that may have other investments and business interests. Issues to consider include:

• Onboarding of new investors and changes in investors and how they will be managed under the franchise agreement.

For example, if the franchisor benefits from pre-emption rights (giving the franchisor first refusal when the company issues new shares or shareholders transfer shares between themselves), agreeing that this no longer applies after they approve a new investor.

• In light of this and other business interests, do the restrictions set out in the franchise agreement need to be varied, as they apply both during the term of the franchise agreement and post-termination?

For example, an obligation on the owner to devote their full time and attention to the business will probably not be appropriate where they intend to appoint one or more managers or they have other non-competing business interests.

• If any guarantees or other security is required and appropriate to be provided, how should it be structured?

In the case of personal guarantees, can they be limited to each investor’s percentage shareholdings in the franchise, rather than being given on a joint and several basis? If there are changes in those shareholdings, can a mechanism be agreed to amend the guarantees and will they be released on predetermined events, such as a share sale?

• Are there any restrictions in the franchise agreement that prohibit security being taken over the franchisee’s business and/or franchise agreement and how can this be addressed?

• Can the approach to opening new sites or operations be agreed now? Will development rights be granted at this stage or are they conditional on the successful opening of one or more sites?

• On what basis will the parties contract? If a separate franchise agreement is to be entered into for each new site, it seems appropriate that any terms that have been specifically negotiated should apply to all franchise agreements to be entered into.

• Can a better deal be done on applicable fees on new openings and any ongoing payments, particularly if calculated on the basis of sales or turnover?

• What happens if one site fails or is terminated and how does this affect the other agreements? In most cases, it wouldn’t be appropriate for the franchisor to have a right to terminate all other agreements.

• What management and financial information is to be provided to the franchisor? Can this be ring fenced from other confidential information relating to the franchisee’s other separate businesses, for example?

• If the franchisee or investors operate other businesses in the same sector, does there need to be any special consideration regarding competition issues?

• If the franchisee has in-house capability where it would normally be obliged to use third party contractors approved or nominated by the franchisor, does the franchisee need to request a change to the agreement?

Similarly, with regard to supplies, does the franchisee wish to use an existing supply chain other than for those products that are demonstrably necessary to be purchased from the franchisor or specialist suppliers?

No standard approach
While there is no standard approach to this, investors should consider their risk appetite and the impact that certain standard provisions in franchise agreements might have on their other business interests and investments and how to structure their relationship with franchisors.

For franchisors, none of these potential adjustments should come as a surprise or adversely affect their position with franchisees.

The important thing is to make sure that the agreement with the franchisee and its investors reflects what needs to happen in practice and that everything is properly addressed at the outset. This will help to ensure that all parties are protected in a fair and reasonable manner.